Dividends on Employer Stock in 401(k) Plan

[401 Chaos]

Forgive me if this is not the correct or best board for this post. (I've seen a similar question on another board that didn't get any responses so thought I might pose the question here given the higher traffic on this board.)

I have a real blind spot with respect to behind-the scenes administration and processing of 401(k) investments. Could someone provide a snapshot of the process for handling dividends paid on employer stock offered as an investment option in a 401(k) plan. (Plan simply permits participants to direct investment to be made in employer stock as one of several options--employer does not make any contributions in employer stock.)

I guess my assumption is that cash dividends owed to each participant would be calculated and paid to the plan / trustee just like with regular shareholders and that the plan would then allocate and invest those cash amounts in accordance with the participants' investment elections on the date received (i.e., that the cash dividends could be used to buy additional shares of company stock plus other mutual funds the participant had elected and would not simply be plowed back into employer stock alone). If so, are the dividends usually allocated immediately or are they commonly held and combined with other contributions (e.g., the elective salary deferrals under the next paycheck)? I am also curious to know what plans typically do about fractional shares of employer stock.

Thanks for any light that can be shed on the general process invovled.

[MoJo]

Typically any income generated from any investment in reinvested back in that same investment. So, dividends on the company stock fund will be reinvested in additional shares or units of company stock - as would be the case for any dividends or gain distributions paid by any mutual fund held within the plan. In some cases, if the plan is appropirately designed, a participant may opt to receive payment of dividends on employer stock in cash - paid "through" the plan....

[QDROphile]

Either the plan document or an investment policy document will dictate the dispositon of cash dividends. Same for stock dividends and fractional shares. For public companies it is common for cash dividends to be reinvested in employer securities unless there are directions to the contrary. ESOPs have their own considerations. A plan of public company that pays dividends that has a company stock investment option will probably be an ESOP.

[401 Chaos]

Thanks to both of you for the responses. This is very helpful. We are still trying to obtain a copy of the plan from the client but my understanding is that the plan docs may not directly address these issues.

A couple of follow ups if you don't mind:

MoJo: I see some of the company stock funds discussing stock in units rather than shares and your response references both. What is the difference from an administrative aspect? If the holdings are in units rather than shares, I am assuming the trustee or somebody is still buying actual shares to cover the various investments but maybe just not allocating those shares to individual accounts on a daily basis and instead referring to them as units? Maybe there is no real difference from the perspective of what the plan / accounts actually hold and I'm just confusing myself?

QDRO: could you elaborate a bit on your comment that the plan is probably an ESOP if it involves a public company that pays dividends on stock in the company stock fund? Would that mean that the whole plan or just the company stock fund would be subject to additional / different ESOP rules? (In this case, participants are able to move in and out of the company stock fund without any restrictions so there is no real intent (desire?) that participants necessarily be invested in company stock.) If the automatic reinvesting of dividends in the company stock fund is what creates ESOP status (as opposed to just having company stock as an investment option in the plan), would that be a reason to provide for different handling of dividends on company stock (if possible)?

Again, many thanks.

[QDROphile]

Typically the company stock fund would be the ESOP portion of the plan and the dividend would either be paid to participants or reinvested in employer securities, at the direction of the participant. The plan document will have appropriate provisions. The ESOP board has posts concerning ESOPs that are defined by the stock fund rather than by legitimate criteria. Notwithstanding the bogus nature of the arrangements, they are common and honored.